Andre, Buying Calls: Make The Profits & Exit The Trade

fromAdam Khoo

Hi Andre,

With buying shares of stock, closing your position is pretty
straightforward. When the stock price moves up, simply sell your
shares and collect your money. If the stock price decreases, then
you can choose to sell and cut your losses when any of the criteria
for value or momentum stocks is violated.

What about Call Options? When and how should you sell them to take
your profits or cut your losses? Before you buy any Calls Options
on bullish stocks, you need to plan on WHEN and HOW you are going
to exit your trade. Here are three common scenarios that could
happen:

Scenario 1: Sell The Call Options for a Profit

This is the most common way to exit the trade. When the stock price
moves beyond the breakeven point and your Call Options increase in
value, you sell them for nice profit 30 days before expiration
Friday!

For example, BLUD stock is trading at $25.97 and you expect it to
increase to $31.16. You buy one contract of BLUD March 25 Calls at
$3.50 and pay $350 ($3.50 x 100 Calls).

From your calculations earlier on, you find that BLUD's stock price
must increase beyond $28.50 for you to breakeven.

If BLUD's stock price increases to $31.16, your Call Options will
now be worth $8.16 (Intrinsic value of $6.16 + Time value of $2).

So, you will sell your 100 Calls for $8.16 and receive $816.

Since you paid $350 for your Calls, you gain a profit of $466
($816-$350) giving you a 133% return on investment!

Scenario 2: Exercise the Calls Before Or On Expiration

In this scenario, you exercise the Call Options at expiration and
buy 100 BLUD shares at the lower strike price (i.e. $25) Then, you
sell the shares in the market at the higher price of $31.16,
gaining you a profit of $616 (($31.16-$25) x 100).

Since you paid $350 to buy 100 Calls, your net profit is $266 (i.e.
$616- $350). This is very RARELY USED by Options traders as it
involves having to actually buy the shares and re-selling it.

By waiting till expiration to exercise your Calls, you actually
make less profits than in the first scenario, since your options
have lost all its 'time value'.

Scenario 3: Cutting Losses

There is always a possibility the stock price will not increase
within the time frame or worse, it may move against you! Remember
that the stock has to increase beyond the breakeven price of $28.50
(Strike Price + Option Premium) for you to make a profit (at
expiration).

Instead of waiting until expiration when your time value and the
price of your options goes to zero, it is better to cut your losses
and sell the Call early to avoid losing your entire investment.

I usually cut my losses and sell my Call Options when:

1) The Call Options premium drops 50% below the price I paid
2) Any of the criteria of Value or Momentum investing are violated.
(e.g. the stock reverses into a downtrend)
3) There are 30 days left to expiration.

Through these 3 scenarios, you now have the knowledge to recognize
when is the time to exit.

To your investing success,
Adam
www.SecretsOfMillionaireInvestors.com/index1.htm